India's weight in FII portfolios rises

India's weight in the emerging market portfolios of foreign institutional investors (FIIs) has risen by about 100 basis points in June to 7.96 per cent as compared to May.

This is in contrast with China, whose weight has slipped by 72 basis points in the period. EPFR Global, which tracks global fund flows, said the Chinese markets were seeing redemption pressure, triggered by rising interest rates and alarming reports about the quality of debt of the local governments there.

The increase in India's weight is good news for the markets here and can be partly attributed to lower valuations, which experts suggest already reflect most domestic concerns.

However, experts said unless there were signs of inflation and interest rates peaking and worries over global events (like the Euro zone crisis) subsiding, the markets were likely to remain range-bound.

The Sensex crossed 21,000 in November last year. However, in the first two months of the current calendar year, it fell below 18,000 as foreign investors sold shares (net outflow of Rs 10,000 crore).

Thus, net inflows in the first half of the calendar year have been abysmally low at Rs 2,053 crore (Rs 20.53 billion) compared to Rs 30,242 crore (Rs 302.42 billion) in the same period last year.

This is due to worries over inflation, rising interest rates and crude oil prices, along with premium valuations.

Also, experts said the outperformance of emerging markets (EMs) in the first three months of the current year made the US, European and Japanese markets more attractive in relative terms, leading to lower allocations.

"I think the biggest single factor is the emergence of other markets as viable investment destinations, meaning that the EM allocation pie is cut more ways," says Cameron Brandt, global markets analyst, EPFR Global.

Foreign funds have returned of late as valuations have become reasonable. A July 12 report on Indian markets by ICRA Equity Research says, "Strong corporate earnings growth and flat equity indices over the last 12-18 months have resulted in a healthy time correction, making valuations appear more reasonable."

According to the report, the Nifty is currently trading at a price to earnings of about 15 based on forward earnings, versus about 20 in March last year and about 22 in December 2007.

After seeing a net outflow of Rs 5,158 crore (Rs 51.58 billion) in May 2011, the Indian markets saw a net inflow of Rs 3,310 crore (Rs 33.1 billion)

in June.

In fact, in the current month (till July 14th), FIIs have invested Rs 6,475 crore (Rs 64.75 billion), three times more than what they invested in the first six months of the current calendar year.

EPFR Global says the flows are likely to be choppy for most markets. "There are too many potential flash points out there at the moment – inflation, the euro zone debt crisis, political instability."

ICRA's analysts said, "The impact of gradual unwinding of the massive fiscal and monetary stimulus by developed economies, monetary tightening by emerging economies and the ongoing sovereign debt crisis in the peripheral euro zone will be crucial for the market."

Ramesh Damani, member, Bombay Stock Exchange, believes the second half of the current year will be better for the markets as interest rates and inflation will peak out.

In the long term, there is little doubt about the EM story, which is reflected in the steady flows enjoyed by EM Bond Funds in recent weeks.

India v/s China

Though India gained some weight among EMs compared to China, the latter still accounts for double the weight in the EM portfolio (15 per cent).

On this large gap, EPFR's Cameron Brandt says China is viewed as a stronger short-term story and India a better long-term story.

"Given the quarterly results imperative that drives many fund managers, it's not surprising that they are making hay with China's FDI-driven growth story while they can. Also, the growing role of passively-managed funds guided by indexes derived - wholly or in part – from market capitalisation means that China's total capitalisation advantage over India has a direct bearing on FII flows."

Experts also believe that a lot of state-owned companies have listed in China, whereas India is in the process of listing some of its national companies, which will broaden the investing universe.

This, in turn, creates a good chance that India can increase its share of the global fund pie. In fact, it was only during Coal India's initial public offer that India's weight rose to its highest level, crossing the 8 per cent mark.

Considering that many large public sector companies plan to come out with public issues in the coming months, experts say there is a possibility that India will attract more foreign funds.